DUMMERSTON, Vt. -- Those who thought that last week's government bailout of Fannie Mae and Freddie Mac would stabilize the financial markets got a wakeup call this week.

Lehman Brothers, the fourth-largest U.S. investment bank,
succumbed to the subprime mortgage crisis it helped create with the
biggest bankruptcy filing in history. The collapse of the
158-year-old firm, which listed more than $613 billion of debt,
dwarfs the previous record-setting bankruptcies of WorldCom in 2002
and Drexel Burnham Lambert in 1990.

Merrill Lynch, the world's largest and most widely recognized
brokerage, tried to avoid a similar fate with a $50 billion
transaction to become part of Bank of America Corp. The deal creates
a financial giant rivaling Citigroup, the biggest U.S. bank in terms
of assets. But Bank of America is still trying to digest another
troubled company - Countrywide Financial, the leading subprime
mortgage lender that was about to go belly-up before BofA took it
over earlier this year.

And on Wednesday morning, Americans woke up to the news that
they were new owners of the world's largest insurance company. The
Federal Reserve on Tuesday night employed powers granted during the
Great Depression to extend an emergency loan worth up to $85 billion
that effectively gives taxpayers an 80 percent stake in the company.

The one thread in these companies' fates is that all were
heavily exposed in the new world of finance that helped spawn the
subprime crisis.

Once upon a time, a bank accepted deposits and lent the money
out to stable long-term clients. The deposits were federally-insured
and if the bank found itself in a cash crunch, the Federal Reserve
stood by to offer a line of credit. Now, most of the business of
finance is carried out by "nondepository" institutions - investment
banks such as the late Bear Stearns and Lehman Brothers, which
shuffle money through hedge funds, structured investment vehicles and
credit default swaps.

These high risk, high leverage activities aren't sustainable
when no one knows what anything is worth. That's because many of
these investments are backed by assets that no longer have value,
such as the hundreds of thousands of foreclosed houses across America.

This is completely uncharted territory for the U.S. economy.
It's not just what's become known as the "shadow banking sector" that's
in trouble. It's the regular banks and insurers that are looking more
and more precarious.

Between $200 billion to rescue mortgage finance firms Fannie
Fae and Freddie Mac, the $29 billion loan to broker the forced sale
of Bear Stearns to J.P. Morgan Chase last March, the $300 billion for
the Federal Housing Administration and the billions of dollars the
Fed has pumped into commercial banks, investment banks and AIG to keep them afloat, taxpayers are now potentially on the hook for morethan $900 billion of dubious investments.

If no one else comes knocking at the Fed's door, that $900
billion is daunting enough. Auto makers, airlines and other
struggling businesses will be looking for the same treatment as AIG.
We are seeing the federal government expand an economic system where
profits are privatized and losses are socialized.

It's been six months since the Fed stepped in to broker the
sale of Bear Stearns. There still is no plan for an orderly
liquidation of assets of the failing financial institutions. There
has been no real effort to crack down on the shadow banking sector
and to re-regulate financial markets.

What happens next? We could be in a situation where everyone
tries to sell off their assets only to find there are few or no buyers. The result is that the value of these assets fall, and you have a
situation where everything is for sale but no one has the money to
buy.

That's what happened in the Great Depression, and only the
massive mobilization of the American economy to fight World War II
pulled this country out of the ditch. Those were the days when the
United States had lots of oil and was the world's mightiest
industrial power. Now we import 80 percent of our oil, have
outsourced our industry and are watching mind-boggling amounts of
capital vanish.

This is truly a frightening time. Neither Barack Obama nor
John McCain seem to understand the enormity of what is facing the
country, and neither have been honest about what it will mean for
every American. Neither have come up with plausible solutions. And
regardless of who wins in November, they will get clobbered by the
ugly reality of an economic crisis without precedent.

Many are calling for the creation of a new version of the
Resolution Trust Corp., the largely-taxpayer financed company that
was created in 1989 to deal with the aftermath of the failure of
hundreds of savings and loans. The RTC seized and liquidated the
failed institutions and then went out of business.

A new RTC could perform a similar role in the current crisis
by buying and selling the now-toxic, mortgage-backed assets that are
dragging down banks and Wall Street firms. It would work a lot better
than arbitrarily picking out the winners and losers.

Other reforms are needed, starting with restoring the
Glass-Steagall Act of 1933. After wild speculation brought on the
Great Depression, the Roosevelt Administration pushed for restraints
on Wall Street. Glass-Steagall separated government-insured
commercial banks and the non-federally backed investment banks. By
keeping consumer and speculative capital separate, it made it
possible to understand the activities of all financial organizations.

In 1999, Congress repealed Glass-Steagall and replaced it
with the Gramm-Leach-Bliley Act. It allowed the stockbrokers,
insurance companies and banks to merge for the first time since the
1930s, and ushered in this era of financial irresponsibility.

It's not the Fed's responsibility, or the government's, to
back investment bank speculation and bail out the losers. That's why
sweeping, decisive regulation is needed before things get worse.

Randolph T. Holhut has been a journalist in New England for
nearly 30 years. He edited "The George Seldes Reader" (Barricade
Books). He can be reached at randyholhut@yahoo.com.